Can EU monetarism function without fiscal compatibility?

One of the concerns facing the European Union (EU) as a monetary union is whether it can justly support itself as a politico-economic institution solely utilising monetarism in the absence of a ‘fiscal union’, which would fundamentally require a level of political integration, most notably theorised as a ‘United States of Europe’. Although a federal republic of EU member states conflated into a massive European state would almost mimic the federalist system used in the USA, there is great uncertainty as to whether such a concept would ever come into full fruition. Thus, considering the diverse multitude of cultures, languages, traditions, geographies and values each member state upholds, fiscal and monetary unity of the EU within a political union is unlikely to arise. Consequently, economically speaking, existing solely as a monetary union presents the EU with a multitude of economic challenges, specifically a discord between monetarism and fiscalism.

In layman’s terms, monetary and fiscal policy must be compatible in order to keep any economy stable and functioning; one type of policy cannot do the job alone. Supranational monetary policy and domestic fiscal policy has not yet proven to be an effective method to sustain macroeconomic balance within the EU, which is why there remains growing concerns about the stability of the Economic and Monetary Union of the EU (EMU) itself. This imbalance in policy fundamentally supplemented the European Debt Crisis in 2009 in the wake of the 2008 Financial Crash. In short, the issuance of cheap credit to members of the Eurozone permitted certain governments to embark upon unprecedented levels of deficit spending which underpinned mismanaged fiscal policies. As debts built up, and after the housing market crashed in the United States, governments like Greece and Spain could no longer borrow to pay their financial obligations. If there were an Economic, Monetary and Fiscal Union of the European Union, then not only could the European Central Bank (ECB) control the money supply within the Eurozone, but a separate entity for fiscal policy could control the levels of government spending and effective tax collection of each member state so that another debt crisis is not induced. Some may call this authoritarian and centralised, others may see this as simple macroeconomics to promote growth and stability within Europe.

There have been efforts for fiscal unity in the past. The most obvious piece of direct evidence dates two decades ago in the ‘Stability and Growth Pact (SGP)’, enacted in 1997. The SGP is based on Articles 121 to 126 of the Treaty on the Functioning of the European Union, and basically states that EU governments should have a national debt less than 60 percent of GDP and an annual budget deficit less than 3 percent of GDP (Meyer 2011). In doing so, the value of the euro should remain intact through the effectuation of fiscal responsibility across member states, whilst also restricting fiscal independence to a certain extent. The ‘Euro convergence criteria’ further limits member states’ opportunities for fiscal autonomy by enforcing the SGP, and the ‘Exchange Rate Mechanism’ members must adopt seeks to align monetary policy with that of the EU before they can join the euro.

What the international community seems to be recognising now is how much has been squeezed out of the ECB’s monetarism, regardless of Draghi’s claims that “We have plenty of monetary-policy ammunition, and we intend to use it” (The Editors, 2016). Bloomberg View’s Editorial Board highlight the fact that aggregate demand and growth is still far too low within the euro area, with inflation nearing zero as consumer prices rose by just 0.2 percent in August from the previous year (The Editors, 2016; Ruhe, 2016). Although back in March the ECB cut interest rates to 0 percent from 0.05 percent and further expanded its QE programme to purchasing €80 million worth of bonds a month, up from €60 billion, monetarism continues to be the only fallback to kick start inflationary pressures to the official target of 2 percent (Speciale, Black 2016). Nevertheless, inflation really is not everything, as world renowned economist Joseph Stiglitz admonishes in his interview for ‘Social Europe’ with regards to his recent publication ‘The Euro: How a Common Currency Threatens the Future of Europe’ (Stiglitz, 2016). Stiglitz argues that the ECBs mandate on inflation has ignored the pressing issue of unemployment, with Spain’s unemployment rate only starting to fall to around 20 percent and Greece’s youth unemployment rate at 50 percent (Stiglitz, 2016). Moreover, Stiglitz further suggests that since the eurocrisis, policymakers have overemphasized the role of ‘deficits’ as the fundamental cause of the plight back in 2009, and thus austerity measures have worsened the fiscal stance of many member states (Stiglitz, 2016). However, in order to refocus attentions to another pivotal macroeconomic objective besides inflation, such as unemployment, increased public investment through improved fiscal frameworks within the Eurozone could improve matters. Achim Truger presents this concept in his working paper ‘The Golden Rule of Public Investment – A Necessary and Sufficient Reform of the EU Fiscal Framework’ (Truger, 2016). The continued monetarist approach by the ECB in stimulating the economy via slightly increasing levels of inflation has not yet proven best as a policy for growth, and thus the implementation of a European fiscal authority may create an environment for smoother sailings – increasing demand, augmenting inflationary pressures, ameliorating growth and spurring confidence again in the region.

Although fiscal unionism is unlikely at this point in time, greater reforms to push for monetary and fiscal compatibility must be considered during such economic uncertainty. Efforts for greater fiscal unity have been sought for lately, such as the Fiscal Stability Treaty ratified in 2012, which introduces a new stricter version of the SGP. But as Bank of England Governor Mark Carney stated, “It is difficult to avoid the conclusion that, if the euro were a country, fiscal policy would be substantially more supportive” (Peston, 2015). Hopefully, we shall start to see more fiscal centralisation than monetarist exploitation in the future, for the sake of the EMU.

Chris is currently a first year student studying BSc Government and History at the London School of Economics and Political Science. Although of British-Filipino origin, he has spent most of his secondary school in Hong Kong. His academic areas of interest principally lie in EU macroeconomics, the impact of EU membership upon human rights, EU law and social choice theory. 

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